Background
Property flipping, pre-construction assignments, and general abuse of tax rules had naturally increased as the real estate market in Canada heated up over the past few decades.
In 2016, the Government of Canada announced an administrative change to the Canada Revenue Agency (CRA)’s reporting requirements for the sale of a principal residence on Form T2091. Then, in 2022, the government enacted new rules to address discrepancies in the taxation of property “flipping” and the assignment of pre-construction contracts.
But why did they do this? It was common practice for savvy individuals to purchase property with the intention of quickly “flipping” it to take advantage of the upward trend in house prices. In addition, many investors would purchase pre-construction properties, often requiring only fractional down-payments, and sell them on assignment at a profit before the properties were transferred to them by the builder.
These investors took advantage of several favorable tax rules, including the Principal Residence Exemption (PRE) and Capital Gains (CG) treatment. The former allows Canadians to sell their primary home free of tax, while the latter allowed them to include only half of the gain on their property in their tax returns.
This speculation in the property market, coupled with other factors such as aggressive immigration and low borrowing rates, contributed to the rapid rise in house prices, which outpaced the general increase in wages. As a result, housing affordability was further negatively impacted.
How the Government of Canada Reacted
Over several years, the Government of Canada has implemented measures to address perceived abuses of tax laws in the real estate sector.
To tackle the misuse of the Principal Residence Exemption (PRE), an administrative change was made to the Canada Revenue Agency (CRA)’s reporting requirements for the sale of a principal residence on Form T2091. Before 2016, filing Form T2091, which reports the sale of a principal residence and allocates the PRE, was not mandatory. This change ensures that the CRA can track relevant data more effectively and detect incorrect use or abuse of the PRE.
For 2023 and subsequent taxation years, Budget 2022 introduced a new deeming rule for residential real estate, including rental property, to ensure that profits from flipped property are taxed as business income. Property flipping involves buying residential property and quickly reselling it for a profit, including reselling the rights to purchase a property before its official sale.
The new rule mandates that profits from property flipping be fully taxable as business income, disqualifying them from the 50-per-cent capital gains inclusion rate (66.67% for gains above $250,000 as proposed in the 2024 budget) and the Principal Residence Exemption. A “flipped property” is defined as a housing unit located in Canada, not already considered inventory of the taxpayer, and owned for less than 365 consecutive days before the disposition, unless the sale results from certain life events:
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- Death of the taxpayer or a related person.
- A related person joining the taxpayer’s household or vice versa (e.g., birth of a child, adoption, care of an elderly parent).
- Breakdown of a marriage or common-law partnership, with separation for at least 90 days before the sale.
- Threat to personal safety (e.g., domestic violence).
- Serious disability or illness of the taxpayer or a related person.
- Involuntary job termination of the taxpayer or their spouse/common-law partner.
- Eligible relocation (e.g., to carry on business, employment, or full-time post-secondary education).
- Insolvency of the taxpayer (e.g., due to debt accumulation).
- Destruction or expropriation of the property (e.g., natural or man-made disaster).
For taxpayers who own a right to acquire a housing unit, the 12-month holding period resets once they secure ownership of the property.
Starting January 1, 2023, this new deeming rule ensures that profits from flipped properties are fully included as business income. Profits from these sales cannot be treated as capital gains, and the Principal Residence Exemption is not available. The 2022 Fall Economic Statement extended this rule to include profits from the assignment sale of rights to purchase a residential property if assigned before the end of the 12-month holding period.
Any losses from the sale of flipped property are deemed nil, as the property is considered “personal” property. This new rule applies to transactions occurring on or after January 1, 2023. If the new deeming rule does not apply because the property is not considered flipped (e.g., due to a qualifying life event or ownership for at least 365 days), it remains a question of fact whether profits are taxed as business income or capital gain, following standard guidance.
But what about GST/HST and assignment sales?
Alongside the new rules on property flipping, the Government of Canada has also implemented changes to the GST/HST implications on assignment sales. In Canada, GST/HST applies to the sale of newly constructed or substantially renovated residential property.
Typically, a pre-construction residential property purchase agreement sets the closing date months, or even years, in advance. As purchasers wait for construction to complete, some may choose to assign their rights under the purchase agreement to another buyer for a fee.
The 2022 Federal Budget introduced new tax rules affecting both the assignors and assignees in these transactions.
Consider Jessy, who bought a pre-construction town house in Vaughan in 2017 for $400,000 (including HST), with a tentative closing date in Dec 2022. He paid a deposit of $80,000 to the builder.
Initially, Jessy intended to live in the condo, but over time, his circumstances changed, and he decided to move elsewhere. Fortunately, the market value of his town house rose to $700,000. In July 2022, he assigns his rights under the purchase agreement to a new buyer willing to pay $280,000 ($80,000 to reimburse his deposit and $200,000 as profit). Jessy was under the impression that he walked away with a $200,000 profit but did not consider the GST/HST implications.
GST/HST to Apply on All Assignment Sales
Effective May 7, 2022, the Excise Tax Act (Canada) (ETA) requires that all assignors of residential real estate collect GST/HST on their assignment profit and remit it to the CRA. This rule applies even to those who do not consider themselves engaged in real estate construction or business and do not have a GST/HST registration.
In Jessy’s case, he would have to remit 13% HST on his $200,000 assignment profit ($23,008) directly to the CRA.
Before this Budget proposal, Jessy’s HST liability depended on whether he purchased and assigned the town house as part of a commercial activity. If his original intention was to live in the town house, he may have been exempt from HST.
These changes underscore the importance of understanding the tax implications of assignment sales and the need to comply with new GST/HST regulations.
Conclusion
The Government of Canada’s recent measures to crack down on property flipping and pre-construction assignment sales represent a significant shift in the taxation landscape for real estate transactions. By introducing stricter reporting requirements and new deeming rules, the government aims to curtail the misuse of tax exemptions and ensure that profits from these activities are appropriately taxed as business income.
These changes, while addressing tax loopholes, also highlight the need for property investors to be well-informed about the evolving tax regulations. The mandatory reporting of the Principal Residence Exemption, the full income inclusion of profits from flipped properties, and the application of GST/HST on assignment sales are crucial elements that investors must navigate to remain compliant and avoid unexpected tax liabilities.
As the real estate market continues to evolve, staying updated on tax policies and seeking professional advice will be essential for investors. These regulatory changes are not just about compliance; they also reflect broader efforts to stabilize the housing market and improve affordability for all Canadians. Understanding and adapting to these changes is key to making informed investment decisions in the dynamic real estate market of Canada.
